Month: February 2019

Buying commercial real estate can be a good investment opportunity. Commercial properties typically offer more financial reward than residential investments, but commercial investments are often more complicated and come with more risks. That is why it is particularly important to exercise great care when conducting your due diligence.

In a commercial transaction, as in a residential transaction, you will have a period to conduct your necessary due diligence. Since commercial real estate is significantly more complicated than residential acquisitions, there is much more to investigate during your due diligence period. A few of the more important due diligence items in commercial real estate transactions are discussed below. If you are considering purchasing commercial real estate, this post is important to review.

Zoning

A thorough and careful assessment of whether the current use of the property and/or the intended use of the property conforms to the municipal zoning code is critical. If the property is in violation of the zoning regulations, you will be in for a major headache down the road.

If you are purchasing a commercial property and do not intend to change the use, one thing you can and should do to determine whether the property complies with the zoning regulations is to request a certificate of zoning compliance from the City or Town planning and zoning department. The zoning officer will conduct an examination of the property and if the property is compliant, s/he will issue a certificate of compliance stating that the property contains no violations. This will provide you with a certain level of assurance that there are no violations at the property. In addition to obtaining this certificate from the town, a contractual representation by the seller that there are no violations will also provide you with protection. The Seller representation and zoning compliance certificate may also serve as a basis for a lawsuit against the Seller and/or Town if it in fact turns out there is a zoning problem after you close.

If you intend to change the use or substantially alter the Property (e.g. construct an addition), in addition to zoning compliance certificate, you should also carefully research whether your intended use is permitted by the zoning regulations. For example, if the property is currently vacant and you intend to lease to a medical practice, you should make sure the zoning regulations permit the use of the property as a medical practice. Similarly, if you intend to physically alter the property, such as construct an addition, you should make sure that the planned alterations are permitted by the zoning regulations (e.g. bulk, setback, and height requirements). You should consider sitting down with staff from the planning and zoning department to go over your project and the intended use so there are no surprises down the road with the zoning regulations. You may need to obtain a permit for your intended use and this should be accounted for when drafting the purchase and sale agreement.

The due diligence contingency provision is important in any real estate transaction but is of particular importance in a commercial transaction. The due diligence provision should be carefully drafted so as to allow you to investigate the zoning regulations and determine whether your intended use and/or alterations are permitted by the zoning regulations. If it is anticipated that you will need a permit from the town, such as a special permit, you should strongly consider a contingency provision that makes the deal contingent on obtaining the necessary permit.

As you can see, zoning issues are significantly more complicated in commercial real estate transactions. This is why it is imperative to carefully conduct your zoning due diligence and include the necessary provisions in the contract to protect you.

Title

It is essential to conduct a careful review of the title of any real property before moving forward to closing, but there are often complicated nuances in the title of commercial real estate that any investor should be ready for if thinking about purchasing commercial property. For example, there may be more complicated leases with commercial tenants than your typical residential tenants. Such leases may contain provisions such as options to purchase, covenants not to lease space to tenants that would cause competition to a particular tenant, longer terms, expansion provisions (giving tenants rights to expand into additional space in the future), and sublease arrangements with subtenants. Reviewing the tenant leases is important in any real estate transaction but of particular importance in commercial transaction due to the various additional provisions that may appear in commercial leases.

Moreover, there are various other types of title issues you may encounter in commercial transactions that typically do not appear in residential. For example, I have encountered several commercial deals where a municipal redevelopment contract was recorded against the title and governed the development of the property, and also contained certain restrictions on the use. This meant that at some time in the past, the town gave a sweetheart deal to a developer (usually in an area in need of redevelopment) and the developer in return promised to build a certain type of building that promoted certain uses. Both deals closed, but my clients had to confirm that the intended use not only conformed to the zoning regulations but also to the redevelopment contract as well. This is one example of a title issue that may appear in a commercial deal that would not manifest in a residential transaction.

As a final point, title insurance is generally more complicated in a commercial deal. Title insurance is a form of indemnity insurance which insures against title defects, unrecorded deeds and easements, boundary line disputes, among other potential title problems. Title insurance is generally required by lenders to protect their mortgage. The lender will typically require a more comprehensive title insurance policy with endorsements typically not required on a residential purchase. These endorsements may insure zoning, usury, environmental liens, mineral rights, along with other matters. Certain endorsements may also be required for certain types of loans such as construction loans.

In summary, you should be ready to face more complicated title issues in commercial real estate transactions. With the proper knowledge and guidance, you should be able to navigate any title issue that comes your way.

Environmental

Another major differences between due diligence in commercial and residential real estate transactions is that environmental due diligence is often required in commercial transactions. Lenders will often require some form of environmental due diligence before allowing you to close the deal. Such environmental due diligence is typically performed by retaining environmental professionals to conduct a “Phase 1 environmental site assessment,” and if necessary, a “Phase 2” and “Phase 3” site assessment.

An environmental site assessment is a report prepared by an environmental company for a prospective purchaser that identifies potential or existing environmental contamination liabilities. The environmental site assessment is conducted in sequential stages, with the first stage called a “Phase 1.” If the first stage of investigation reveals existing or potential contamination, then a “Phase 2” and possibly a “Phase 3” are necessary to determine wither contamination exists or the extent of such contamination, along with remediation strategies.

A Phase I site assessment is a non-intrusive site investigation and does not typically involve the sampling of soil, air, groundwater, and/or building materials. During the Phase I investigation, the environmental professionals will conduct a visual inspection of the site and research records from various public sources to identify any present or potential environmental contamination based on the history of the site and neighboring sites. The research will investigate potential soil contamination, ground and surface water quality, along with the presence of hazardous substances on the site, and will include researching files from various municipal and state departments including the planning and zoning department, health department, fire department, and the Department of Environmental and Energy Protection (DEEP). The Phase I will likely include interviewing the current owner and others with knowledge of the site. If the research and interviews conducted during the Phase I reveal no contamination or potential contamination, a Phase II site assessment is unnecessary. If the phase I does reveal such contamination or potential contamination, a Phase II will then be required.

A Phase II is generally more involved than a Phase I. A Phase II, unlike a Phase I, involves investigations which collect samples of soil, groundwater, and other materials to test to determine whether such samples contain contamination. Common substances tested include petroleum, hydrocarbons, solvents, and sometimes asbestos and mold. Depending on the substances tested, a Phase II could take significantly longer than the initial Phase I test.

If the Phase II reveals contamination, a Phase III will likely be required. The Phase III aims to determine the extent of the contamination and may involve further testing, often more extensive than the Phase II testing. The Phase III will typically provide strategies for a remediation along with recommendation for site monitoring after the cleanup. Remediation methods can vary greatly depending on the type of and extent of contamination, ranging from soil excavation to more complicated soil vapor extraction systems.

It is essential to understand whether there is any contamination on the site before closing the deal. This is particularly important in Connecticut that has a statute called the Connecticut Transfer Act on the books, which regulates the transfer of certain types of polluted sites and requires a party to file certain forms that certify that the site is clean or if polluted, will be remediated.

Moreover, remediation can be very expensive and may make your investment economically unfeasible. Therefore, it is important to have the right environmental professionals conduct your investigations to understand what types of environmental issues are on the site. It is also essential to make sure the contract contains a carefully drafted due diligence clause that allows you to conduct such environmental site inspections and terminate the contract if the results are unsatisfactory.

Financial Due Diligence

Financial due diligence in commercial real estate transactions is complicated and involves a careful review of numerous legal and financial documents. This investigation is critical to assess whether the investment is economically feasible and will generate the desired revenue. Some of these documents should be reviewed by your attorney while others should be reviewed by your accountant/financial professionals. The following are some of the key documents that you should review with your attorney and accountant during your financial due diligence:

Tenant files, including leases, amendments, subleases, and any related documents

As mentioned above, the financial due diligence is key in determining whether the investment makes economic sense. It is therefore essential to make sure that the due diligence contingency in the contract includes financial review and requires the Seller to provide the relevant documents.

In Summary

In summary, commercial real estate transactions are significantly more complicated than residential transactions and involve risks not present in residential transactions. This is why it is imperative to conduct extensive due diligence and assemble the proper team of financial, environmental, and legal professionals. Moreover, it is important that your due diligence provision in the real estate contract is carefully drafted to allow you to conduct extensive investigations and to terminate the contract if any such investigations are not to your satisfaction. I have extensive experience drafting contracts and helping buyers conduct their due diligence, and I would be happy to help you and your team in your next deal.

Every real estate investor should know the basics about land use permits. Sure, many investments will be residential buildings or multi-families where there will be no change of use after the purchase, but many investors will eventually get involved in bigger commercial acquisitions. This is when you may have different commercial tenants coming in and looking to (in addition to paying a great monthly rent) change the use of the space or perhaps want to develop another part of the property for the intended use. This is where a basic understanding of whether a land use permit will be required is important. Of course, consult an attorney, but understanding the differences between permits and what is involved can help you make good business decisions about commercial tenants. This post will provide some background about some of the common types of land use permits that every investor should know.

Special Permit

A use of property is typically designated by a town as “permitted,” “not permitted” or “permitted by special permit.” If a use is permitted, you generally will not need a permit (except perhaps a zoning permit if you are developing the property, as discussed below). For example, if an accountant’s office is a permitted use in a B1 zone, you generally do not need a permit. If, for example, auto shop is not permitted, then you cannot lease to that tenant (unless you get a variance, discussed below).

However, many uses are special permitted use, which means the use is permitted if you satisfy certain requirements. A public hearing will be required before the Planning and Zoning Commission and the applicant (which can be either the landlord or prospective tenant) will have to demonstrate that the proposed use will not adversely impact the neighborhood / public health and safety. Every town has a list of special permit criteria that the Commission will evaluate to determine whether the use should be allowed, but generally these criteria include thing such as impact on traffic, whether the use is in harmony with the other uses in the neighborhood, septic and environmental impact, noise, and related criteria. Sometime experts are required to testify on the impact of the use which is not cheap.

Therefore, if you are thinking about leasing or developing for a special permitted use, you should realize that there may be a several month and costly process to obtaining the required special permit. The landlord may require the tenant to pay such costs but the tenant is going to require some sort of contract or contingency that the landlord will hold the space while going through the special permit process. These are things to consider before leasing to a tenant that requires a special permit; however, for the right tenant, it could be well worth it.

2. Variance

A variance application requests that the town or city create an exception for the intended use even though it is not permitted under the current regulations. Variances come in two forms – use variances and height / bulk variances. A use variances asks that the town to allow a certain use in a zone that is not permitted by the current regulations. A height and bulk variance asks the town to allow an exception for regulations for setbacks or height. For example, a variance would be required if a proposed use needs a larger building than allowed under the current regulations.

Variances are not easy to obtain and the applicant will generally need to demonstrate that he or she would experience a hardship if the variance is not granted. The hardship cannot be self imposed, but is generally a hardship that is due to the unique shape of the lot or a hardship imposed by a change in the regulations, such as the creation of an undersized lot due to regulation amendments.

Therefore, if a tenant wants to use or develop the property in a way not permitted by the regulations, a variance application is an available avenue. Variances are not easy to obtain but can be effective in requesting an exception from the regulations.

3. Zoning Permit

A zoning permit is typically required where you are developing or using a property for a use that is permitted, but are changing something (either through development or a creating a more intense use). The zoning permit will make sure you have the necessary parking and comply with any other requirements. For example, if a medical facility is permitted on a 2 acre parcel and you are building a medical building, you will likely need to obtain zoning permit to show that you have adequate parking and comply with other specific regulations for this use. Once the town recognizes that your plans have the required parking and comply with all regulations, you will receive the zoning permit.

Investing in multi-family property is a great way to build wealth. Multi-families are also great first investments for new investors looking to make a smaller purchase to get their feet wet before buying something bigger. However, when buying a multi-family property there are a number of legal issues that every real estate investor should be aware of that do not arise when purchasing a condominium or single-family home. I have outlined three important issues to consider when purchasing a multi-family property.

ZONING: IS THE PROPERTY A LEGAL MULTI-FAMILY PROPERTY?

One of the first things I advise clients buying multi-families is that they need to understand whether the property is a legal multi-family. This comes in two forms: it must be either a permitted use under the current zoning regulations or a “legally non-conforming” property. If it is neither, then the purchaser may be in for serious problems down the road. That is why every investor should understand the zoning issues that can arise when purchasing multi-family property and how to navigate through them.

If the multi-family property is a permitted use under the zoning regulations, then you can rest comfortably that the use of the property does not violate the zoning regulations. However, what if the multi-family is in a zone where multi-family property is not a permitted use? Is it an illegal use and therefore a buyer should shy away from the purchase? Not necessarily.

The multi-family property may be a legally non-conforming use. In the world of land use law, a property may not be a permitted use under the current zoning regulations but multi-family may have been a permitted use in the past. A property is considered legally non-conforming if the use complied with the zoning prior to the date that the town changed the zone to remove such use from the zone. For example, if a multi-family was a permitted use in the R2 Zone in 1999 and the town thereafter removed multi-family from the R2 zone, as long as the property was in use as a multi-family prior to the change of zoning it can continue as a multi-family property after the change of zoning as a “legally nonconforming” property.

However, it is possible that an owner illegally converted a property to a multi-family property in a zone that does not permit it. This would mean the property is an illegal multi-family that you do not want to purchase. This is why it is important to explore the zoning and the history of the property to make sure you do not purchase an illegal property. As long as the property is in a zone that permits multi-family or the property is legally – nonconforming, you can safely purchase the property.

I have experience helping clients purchase multi-family homes and can help you with your zoning due diligence to make sure you do not purchase an illegal property.

Buying a multi-family, or any property with tenants, is a transaction that comes with risks and potential exposure to liability that are not inherent in purchasing a residence for you and your family. For example, what if a tenant slips and falls and files a lawsuit against you arguing that her injuries are a result of you failing to comply with your obligations under the lease? What if a tenant accidentally starts a fire that spreads and causes damage to other homes in the surrounding neighborhood? These are examples of the inherent risks in buying multi-family properties. This is why it is imperative to do everything you can to minimize your liability if something goes wrong. One important thing you can do to limit your liability is to create a Limited Liability Company (LLC) and take title in the name of the LLC.

Taking title in the LLC instead of individually will insulate you from personal liability and limit your exposure to the assets of the company – the real estate (there are several narrow exceptions not discussed in this post). In other words, any Plaintiff that obtains a judgment will only be able to look to the company’s assets to satisfy the judgment, which is the real estate. If the property was owned by you individually, a plaintiff could look to the real estate and other personal assets (such as personal bank accounts, other real estate, etc.) to satisfy the judgment. This is why setting up the LLC minimizes liability.

It is of course prudent to also carry an insurance policy on the property. However, an insurance company could deny the claim or its policy limit may be inadequate to cover the claim. Therefore, you should not rely on insurance and setting up the LLC will provide you another layer of protection.

Setting up the LLC may seem like a simple process but there are various things to consider. For example, if you are creating the LLC with more than one member, you should think about creating an operating agreement. This document will essentially detail how the members will manage the company and how they will make decisions. A carefully drafted operating agreement will include provisions that explain the authority of each member; whether the company will be managed by a designated manager or by its members; the process that decisions will be made; the process to be used in taking on new members; how the company will decide a tie vote of its members; along with other important provisions relevant to the operation of the company. Drafting a detailed operating agreement will prevent problems between members in the future.

I have experience setting up limited liability companies for investors and drafting operating agreements for the companies. I can help you set up your real estate holding company and create a detailed operating agreement so you and your partners are protected and avoid problems down the road.

TENANTS AND LEASES: DO YOUR DUE DILIGENCE

When buying any property with tenants, it is essential to do your due diligence with respect to the tenants and the leases. As an investor, you want to make sure that the tenants are current on the rent. You do not want to purchase the property only to learn that the tenants are six months behind on the rent and are vigorously fighting an eviction lawsuit. Therefore, it is prudent to request that the seller and tenant(s) sign a document called an estoppel certificate. This document will require the seller and tenant(s) to make a representation that the leases are in full force and effect and that the tenant is not in default. This will provide you some assurance that the tenants are not behind on the rent.

It is also prudent to thoroughly review each lease. You should be aware of the termination date of each lease and whether the tenant has the option to renew. If the leases are set to terminate a month after closing, you should be prepared for the possibility of vacancies. Moreover, if the tenants have an option to renew, this may interfere with plans to lease to other tenants. Similarly, some leases have options to purchase or “lease to own” arrangements. This type of provision is problematic for any investor as the tenant would have the option to purchase the property after you closed. You would likely not want to move forward with the investment if there was such a provision in any of the leases.

In summary, multi-family properties are great investments to build long-term wealth. However, such investments come with certain risks. Careful planning and proper due diligence will mitigate risk and help prevent future problems.

Investing in vacant land may be an excellent investment if the investor is aware of the risks and can knowledgeably assess the issues unique to developing vacant land. I have helped various real estate professionals purchase and develop vacant land and the following is a list of the key issues that every investor should be aware of before buying and developing vacant land.

Zoning and Subdivision Regulations. What Can I Build? – Before purchasing and developing vacant land, a prudent investor will research the zoning and subdivision regulations to fully understand they can and cannot build on the land. Subdivision regulations will likely impose restrictions on how many lots can be carved out of the vacant land and possibly certain other requirements like requiring open space. Moreover, zoning regulations govern what types of property can be constructed. It is imperative to understand what can be build there before moving forward with the acquisition to understand whether the planned development is feasible. For example, if you would like to construct an apartment building on the lot, make sure that the zoning regulations allow this. Working an attorney sooner rather later may save you a big headache down the road.

Will You Need Any Type of Permit for Your Planned Development? –Your intended project, no matter how big or small, may require some sort of permit to make it become reality. For example, if you want to construct a building of a certain size or use, it may be permitted but you may need to obtain a special permit, which will require additional legal and professional fees. If the permit is imperative to what you want to build, you should know this ahead of time so you can make the deal contingent on obtaining the permit. It better to know before you sign rather than after you close whether you need a permit for your project.

Sewer and Utilities –Prior to purchasing vacant land, another important component to understand is whether the land is connected to the sewer line and utilities. If not, this could impose additional cost on your budget. Moreover, the ability to connect to the sewer is important to understand which could increase the development potential and value of your property. If the land is not connected to the sewer, a septic system will not only increase the cost of your development but may limit the square footage of development potential. Accordingly, it is important to understand to what extent the land is connected to utilities to assess the development potential and costs of the project.

Environmental Concerns – Environmental Concerns are always an issue when purchasing real estate. However, they are more of a focus on vacant land, especially in commercial areas, when the land is going to be dug up and developed. If you are contemplating purchasing vacant land, particularly in a commercial area, you should strongly consider consulting with environmental professionals and conducting environmental testing to make sure there are no hazardous contaminants on the land. If you discover such contaminants after the purchase, you will have a big problem on your hand.

Due Diligence Provision in Land Acquisitions –Due to the unique issues involved in purchasing vacant land, it is important to have a broad, carefully drafted due diligence provision, that allows you to conduct due diligence on zoning, utilities, environmental and so forth. The standard due diligence provision in a residential real estate contract is likely insufficient. Before you sign a contract for land, make sure you review the due diligence clause carefully and make sure it includes your right to conduct due diligence broadly.

Wholesaling is becoming a more and more popular way that investors do deals. Wholesaling, like any real estate investment, has positives and negatives aspects. As a lawyer who has handled a fair amount of wholesale deals, I made a list of five legal issues that every investor should be aware of before getting involved in a wholesale transaction.

Make Sure The Contract Is Assignable – Not every contract is assignable, which is the mechanism that wholesalers use to sell their interest in the contract for a fee. Every county in Connecticut has a slightly different purchase and sale agreement, and many have also been tinkered by real estate agents and attorneys. Moreover, I see more investors using forms they have downloaded from various websites. If you are going to wholesale a contract, you need to make sure the contract is clear that you, as the Buyer, have the right to assign the contract to anyone in your sole discretion. If there is no such clause, arguably you may have to perform and you cannot sell the contract. Make sure the contact has a clear provision that you have the right to assign your interest.

LLC – Any real estate transaction has risks. Wholesaling a deal is no different. Therefore, it benefits you and mitigates risk if you enter into the contract with a limited liability company instead of as an individual. In the event that something goes south and there is litigation, it is much better if your LLC is a party and not you, and hopefully your LLC does not own many assets.

Due Diligence Items – Due diligence items in the contract are essential even in a wholesale deal where you ultimately will not close. You should include the same due diligence items in the contract as if you were planning on purchasing the property. These due diligence items at a minimum are an inspection contingency clause and a mortgage contingency clause. I always advise clients wholesaling that they should push the contingency dates out as far as possible to allow you time to find a new buyer and give the new buyer enough time to do an inspection and/or apply for a mortgage. Keep in mind that the new buyer who you wholesale to will essentially step into your shoes and will have the same due diligence rights as when you signed the contract, so think carefully about them with the help of an attorney.

You May Have To Perform – If you cannot find a new buyer by the closing date, you may have to close on the property depending on how you draft the contract. If the Seller will not allow an exit provision if you cannot wholesale the contract, you will have to close or breach. If this is unacceptable, make sure there is a contingency clause that addresses this.

If you are the Seller, Make Sure Buyer #1 on the hook if Buyer #2 does not perform –The Seller may allow you to assign the contract to a new buyer but insist that if that new buyer does not close, you are then required to close. When I represent sellers in wholesaling deals, I insist on this provision to protect the seller. Be prepared for this type of negotiation. Putting more money down may make the Seller more comfortable and not insist on such a provision (then you can seek reimbursement for the deposit from your new buyer).

I have had a number of clients who are both homeowners and contractors ask me to review a contract for home improvements (addition, pool, deck, etc.) and request that I review the contract to make sure it contains all of the necessary information. They are surprised to learn that their contract is woefully deficient and in fact, may not be enforceable unless certain provisions are added. It is particularly important as a contractor to make sure your contract is enforceable by a court of law if you get stiffed for the final bill.

Under the Connecticut Home Improvement Act, all home improvement contracts must comply with nine (9) requirements in order to be enforceable. Court cases have ruled that failure to include some of the lesser important provisions will not render a home improvement contract unenforceable, but it is still a good idea to include all of these provisions.

The first statutory requirement is that the home improvement contract must be in writing and include the scope of services. Therefore, if you are a contractor, it is a good idea to take the time and have a standard written contract to use with clients and have it executed before you start work (although the scope of work will change). If you do not, it may be very difficult to enforce your agreement.

The contract must also be signed by the both the contractor and homeowner to be enforceable. This is a little bit different than standard contract law which only requires the signature of the party you are trying to enforce the contract against. The contract must also contain the company name of the contractor and registration number. The registration number ensures that the contractor is registered.

The contract must also contain a start date and completion date. Some contracts only include start dates and fail to include completion dates. This is a mistake. As a contractor, you want to include an estimated completion date. If you do not, and you do not get paid, the home owner may argue that it is not enforceable because the contract does not comply with law. On a related note, the contract must also contain the date of the transaction.

The law also requires certain provisions in the contract, including a notice of cancellation. The contract must also include a provision providing information about other ownership interests in other home improvement companies. These disclosures are important and failure to include them allows an argument that the contract is unenforceable.

In short, if you are a contractor doing any type of home improvement work, you should be aware that there are statutory requirements that must be included in each contract or you expose the company to an argument that the contract is unenforceable. The last thing you want is to make a demand for the final payment and to give the home owner an argument that they do not have to pay you because you failed to comply with the statutory requirements.

Conversely, if you are a homeowner in dispute with a contractor, you may have leverage if they don’t have the right contract.